Barry Jazzy is the Managing Director of Jazzy Juice Pty. Ltd. which operates a

chain of stores located within major shopping malls. The flagship store is in the

Warriewood Shopping Centre on the Northern Beaches of Sydney. The store

currently achieves annual sales of $200,000 of fresh fruit juice, $20,000 of canned

soft drinks and $15,000 of packaged flavoured milk drinks.

Barry is interested in purchasing the Whizzer 2.0 for the Warriewood store, which

can produce smoothies in addition to the usual fresh fruit juices. The machine

currently sells for $300,000.

In order to assess the suitability of the new machine, Barry consulted Barbara

Boost from the famous Boost Juice family. Barbara charged $1,000 for her advice.

This is immediately fully tax-deductible.

The old juicing machine can be sold for $55,000 to a competitor, Carrot'n'Ginger

Plus. The new machine has the capacity to increase Jazzy Juice's sales of

traditional fruit juices to $250,000 per year. This is expected to remain constant

forever. Sales of smoothies are expected to be $100,000 in the first year, $120,000

in the second year, and to increase by 5% each year thereafter. It is expected,

however, that Jazzy Juice will cease sales of soft drinks and flavoured milk drinks.

Assume all cash flows are in nominal terms.

Some additional tools will be required to run the Whizzer 2.0 machine. These

presently have a cost of $8,000 if purchased new. Barry does however have some

of the required tools at his home. These have a book value of $3,000. He is

relieved he still has them, as he recently tried to sell them but was not able to attract

any buyers.

The cash operating costs of the old machine are $75,000 per year. The new

machine is more expensive to run. It is expected to have operating costs of

$80,000 in the first year and this is expected to increase by 1% each year thereafter

due to the extra maintenance involved with high volumes of production.

Working capital of $20,000 is required immediately. This is mainly for yoghurt, milk

and fruit. Total Net Working Capital at the end of each year will be about 20% of

sales for that year.

The old machine has an expected life of two years. In two year's time the old

machine (if it is kept) could be sold to a scrap merchant for about $2,000.

The new machine has an expected life of four years and could be sold for $70,000

at the end of four years. The new machine will be depreciated down to zero using

the straight-line method. Regarding the new machine, the company plans to

2(3)

depreciate it over the estimate life (4 years). However the Australian Taxation

Office (ATO) stipulates that for tax purposes the effective life of such machines is

5 years. The accountant has specified that they must follow corporate policy and

depreciate over 4 years. The old machine was purchased 3 years ago for $200,000

and Barry has followed the ATO guidelines in determining the depreciation for this

machine, assuming a 5 year life.

The store currently sublets a portion of their floor space to Barry's friend Susan

Spencer, who creates fruit-inspired artwork to sell at local markets. Susan pays

rent to Jazzy Juice of $3,000 per year for the space. This is expected to increase

by 2% at the end of every year. Susan will immediately be asked to leave the

premises so as to fit the new machine.

The company plans to borrow $200,000 from the National Juice Lending Authority,

which charges an interest rate of 6.3% per annum. This is needed to partially

finance the new machine. The interest is tax deductible to the company. The

company will make "interest-only" payments each year, and at the end of the four

years will repay the principal of $200,000.

The current rate of inflation is 3%. Jazzy Juice pays tax at a rate of 30%.

All amounts are in nominal dollars.

The real rate of return of the ASX200 index is 10% pa and the real rate of return

required on such projects is 8% pa. All rates are given as effective annual rates.

Questions:

(a) A pro forma income statement for the project. (8 marks)

(b) Calculation of Operating Cash Flows. (2 marks)

(c) Calculation of Net Capital Spending. (6 marks)

(d) Calculation of the annual change in Net Working Capital. (5 marks)

(e) Calculation of the total project cash flows. (1 mark)

(f) Calculation of the net present value of the cash flows. (2 marks)

(g) Calculation of the internal rate of return on the project. (2 marks)

(h) Calculation of the payback period of the project. (2 marks)

(i) Whether Jazzy Juice should proceed with the purchase of the new machine,

clearly outlining your reasons. (2 marks)